Is Walgreen's Stock Cheap by the Numbers?

Numbers can lie -- yet they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

• The current price multiples.
• The consistency of past earnings and cash flow.
• How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap Walgreen (NYSE: WAG) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow, which divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). As with the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Walgreen has a P/E ratio of 11.6 and an EV/FCF ratio of 16.1 over the trailing 12 months. If we stretch and compare current valuations with the five-year averages for earnings and free cash flow, we see that Walgreen has a P/E ratio of 13.7 and a five-year EV/FCF ratio of 16.9.

A positive one-year ratio of less than 10 for both metrics is ideal (at least in my opinion). For a five-year metric, less than 20 is ideal.

Walgreen has a mixed performance in hitting the ideal targets, but let's see how it stacks up against some of its competitors and industry mates. 

Source: S&P Capital IQ; NM = not meaningful because of losses.

Numerically, we've seen how Walgreen's valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash-flow generation.

In the past five years, Walgreen's net income margin has ranged from 3.2% to 3.7%. In that same time frame, unlevered free cash flow margin has ranged from 0.9% to 4.5%.

How do those figures compare with those of the company's peers? See for yourself:

Source: S&P Capital IQ; margin ranges are combined.

In addition, over the past five years, Walgreen has tallied up five years of positive earnings and five years of positive free cash flow.

Next, let's figure out ...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But even though you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared with similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. In that time period, Walgreen has put up past EPS growth rates of 8.6%. Meanwhile, Wall Street's analysts expect future growth rates of 12.3%.

Here's how Walgreen compares with its peers for trailing-five-year growth (because of losses, Rite Aid's trailing growth rate isn't meaningful):

Source: S&P Capital IQ; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: S&P Capital IQ; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us the price multiples that shares of Walgreen are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at an 11.6 P/E ratio, and we see moderate-to-low price multiples all around for Walgreen. These multiples are quite similar to those of closest comparable CVS.

The margin ranges for Walgreen and CVS show consistent profitabilitly, and both have grown moderately in the past five years.

As another data point, our CAPS community rates Walgreen three stars out of five and CVS five stars. Based on the initial numbers, both Walgreen and CVS seem worth looking into. But all this is just a start. If you find Walgreen's numbers or story compelling, don't stop here. Continue your due-diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.

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